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On 24 March 2015 the Australian Competition and Consumer Commission (ACCC) announced that it intended to deny an application for authorisation of a joint coordination agreement between Qantas and China Eastern Airlines. The decision, although only draft at this stage, has thrown into disarray plans for greater cooperation between the two airlines in terms of coordinating flights and prices between Australia and China and provides valuable insights into the ACCC's approach to assessing the impact on competition of conduct in the global airline industry.

In reaching its draft determination the ACCC accepted that the networks of Qantas and China Eastern are "largely complementary in terms of geographic coverage and destinations served". It found that, although there were considerable public benefits to flow from the proposed joint coordination agreement, those public benefits were not sufficient to outweigh the lessening of competition which it considered would arise from the alliance between competitors on the one route between Australia and China on which Qantas operates direct flights (Sydney to Shanghai).

The determination is a draft only and will not be finalised until interested parties have had an opportunity to make submissions on the draft determination and/or be heard at a pre-determination conference (to be held in late April, if required). If history is any indication, absent any significant evidence to convince the ACCC to change its findings, the draft determination is likely to become final and the two airlines will not be able to give effect to the joint coordination agreement unless an application is made to the Australian Competition Tribunal for review of the determination.

Background

The proposed joint coordination agreement

The proposed conduct which is the subject of the authorisation application to the ACCC is contained in a Coordination Agreement which was entered into between the two airlines on 17 November 2014. The agreement provides for coordination of operations between Australia and China, in respect of pricing and capacity (seats flown), including, among other matters:

improving schedules, frequencies and connection times;

expanding destinations and connecting services

developing new fares and promotions

expanding reciprocal airport lounge access;

co-locating their operations in Terminal 1 at Shanghai Pudong airport

increasing opportunities for each other’s frequent flyers to earn and/or redeem frequent flyer points and take advantage of other membership benefits when travelling with the other airline;

improving reciprocal inventory access to facilitate more bookings on both airlines’ services, including group bookings; and

The proposed agreement would allow each party to sell each other's flight capacity but does not include a "metal neutrality" model (in which the airlines do not care on which airline's flights tickets are sold as long as it is a partner airline).

Flights between Australia and China

The ACCC conducted an in-depth investigation into the provision of flights between Australia and China, as part of its analysis of the application. It found that Qantas and China Eastern currently compete for direct daily flights between Sydney and Shanghai, that each also offer indirect services between the two countries (principally through Singapore) and that their existing codeshare arrangement allows them to codeshare on their respective domestic services. It also found that Qantas accesses China through a number of other codeshare arrangements including with China Southern and via Hong Kong with Cathay Pacific. Other airlines flying between Australia and China include Air China, Sichuan Airlines, Malaysia Airlines and Singapore Airlines.

The authorisation process

The ACCC has power to authorise conduct which would otherwise be a breach of certain provisions of the Competition and Consumer Act 2010 (Cth) (CCA). This includes authorising cartel conduct between competitors such as price fixing and market sharing. It can only do so if it is satisfied that the likely benefit to the public from the proposed conduct would outweigh the likely detriment to the public, including from any lessening of competition (referred to as the "net public benefit test").

The authorisation process is a public one in which, upon receipt of an application for authorisation, the ACCC conducts its own enquiries and public consultation process before delivering a draft determination. Once a draft determination has been delivered a public consultation process begins on the draft determination (which can include a pre-determination conference, if requested, before delivery of the final determination. The process has a statutory completion timeframe of 6 months. A party or parties who are unhappy with the final determination may seek to have the determination reviewed by the Australian Competition Tribunal. Such a review occurs by way of re-hearing and requires the Tribunal to reach its own conclusions.

The ACCC's findings

The ACCC has indicated its intention to deny the application for authorisation because it is not satisfied that the likely benefit to the public from the proposed conduct would outweigh the likely detriment to the public, including from any lessening of competition.

The ACCC accepted that there were a number of public benefits flowing from the proposed coordination agreement, particularly in terms of improved connectivity for onward travel for Qantas passengers on flights to Shanghai, better choice of flight times for passengers, more efficient handling of freight and transiting of passengers through terminal co-location, potential enhancement of loyalty programs and a small impact on tourism and trade between Australia and China.

In the ACCC's opinion, these public benefits are not sufficient to outweigh what it considers to be the significant public detriment which will occur in respect of the Sydney to Shanghai passenger route on which Qantas and China Eastern will have an "increased ability and incentive to unilaterally reduce capacity, or limit growth in capacity, to increase air fares". This is the only area of competition in which the ACCC found any significant impact by reason of the proposed joint coordination agreement.

In arriving at this view the ACCC considered the airlines' combined share of capacity (number of seats) and passengers, whether their services are close substitutes, the competitive constraint imposed by other airlines and the likelihood of timely entry or expansion on the route if the airlines attempted to reduce or limit growth in capacity (in order to raise airfares). With a combined share of 83% and Air China's falling share, the ACCC found that it "may be profitable for the alliance to unilaterally reduce or limit growth in capacity to raise airfares". It also found that other airlines were unlikely to provide a significant competitive constraint on the airline sunder the proposed coordination agreement.

The ACCC considered, but rejected, the possibility of approving the application for authorisation on the basis that the parties accept a structural capacity condition because the establishment of the correct capacity growth rate was too problematic.

Is the ACCC's decision surprising?

It is perhaps not surprising that the ACCC has chosen to discount the constraint on competition from providers of indirect flights between Sydney and Shanghai, this being consistent with previous findings that indirect routes generally can come with time penalties that reduce their substitutability with direct services. However, as many airlines are reducing direct flights between Australia and overseas destinations it may be that such time penalties become more accepted and indirect flights become a more significant competitive constraint.

The ACCC's concerns about the difficulties posed in designing a capacity condition which would address its concerns that the public benefit likely to result from the proposed joint coordination agreement will not outweigh the likely public detriment are more surprising. While the difficulties inherent in setting a capacity condition which is too high or one which is too low is recognised, such pessimism fails to recognise that capacity adaptation in aviation can be relatively quick – as quick as moving planes from one location to another.

Where to from here?

The draft determination is undoubtedly a blow for both airlines. Both airlines are reviewing the draft determination and are expected to seek to convince the ACCC to change its mind. If that cannot be done prior to delivery of the final determination it would not be surprising to see the matter referred to the Australian Competition Tribunal for review. Until then, there will be no smooth landings for the proposed joint Coordination agreement.

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